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Is the pie getting larger?

2008-09-03

In an article entitled “The Pie’s Getting Larger” — What Warren Buffet Means, economist Diane Lim tries to explain the post-Mercantilist philosophy that we can incur more debt because the ability to convert raw materials into wealth continues to improve. So the US can bear more debt, and accept a smaller slice of the world economic pie, because the pie itself continues to grow.

Taking the government’s own GDP numbers at face value, there is evidence to suggest that our pie, that is the US slice of the pie, is not growing in the 21st century like it grew in the 20th. In fact, as Dr. Lim is eminently qualified to point out, someone entering the workforce today will likely see only 39% per capita growth in Real GDP during their productive years, compared to 89% for “Generation X” and 123% for the “Baby Boomer” generation.

Of course, that means we take Real GDP at face value. The problem is that Real GDP includes the implicit assumption that the government is calculating inflation numbers accurately. In fact, inflation calculations are more art than science, and a lot of very smart people are questioning their basis, both in the US and elsewhere.

The basis for consumer price inflation is the “consumption basket” — a list of consumer goods and services that a typical family will consume. You then look at the changes in price for the items in the “basket” and attempt to calculate an index number reflective of that total. As a BEA economist points out:

For very long intervals, the assumptions necessary to produce direct indexes become insupportable. Suppose, for example, one wished to compare the change in a fixed standard of living between 1930 and 1990. Such a question becomes conceptually problematic because over an interval of 60 years, too many changes have occurred in the economy, in the way people live, and in tastes and customs. It might be reasonable to assume that economic conditions are sufficiently constant over, say, 5 years, so that a meaningful cost-of-living index can be computed. Computing one over 10 years poses perhaps a few more problems (for example, new goods are introduced or tastes change), but the calculations may still be useful because the assumptions necessary to make such calculations are not sufficiently implausible as to render the interpretation of the numbers meaningless. The problematical parts become increasingly of concern as the interval lengthens to 15, 20, or 25 years.

The same is true of business; if a company had to buy sewing machines in 1960 to be competitive, today they are buying computers and Internet connections. Consumer or business, the “basket” of goods and services is not constant and cannot be directly compared over time. My father would look at a cell phone, computer and an Internet connection and rightfully see them as 21st century wonders, but they are true necessities for the modern information worker. I look at the low gas prices and home prices that he grew up with and wonder why I can’t afford a decent place to live close to where I work so I can spend time with my family. Deep feelings of inequity can’t be erased by government proclamation.

And that’s part of the problem: per-capita GDP, even if we trust the inflation numbers, doesn’t really tell the story. Even when we can agree on a “consumption basket” that stretches across the generations, we find that the poorest segments of society are not really making any gains at all.

When it comes to trickle-down economics, I’m on board. If we’re going to hook our future to this least-evil-of-all engine we call capitalism, then we accept that there will always be a substantial difference between the most affluent and least affluent members of society. The question is, are the people at the bottom and middle of the scale enjoying some growth? Does their quality of life grow as the pie grows? If a 39% increase in the pie goes to the most affluent sector, then a larger pie will be little consolation.

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